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Framework Framework for the Preparation and Presentation of Financial Statements The IASB Framework was approved by the IASC Board in April 1989 for publication in July 1989, and adopted by the IASB in April 2001. © IASCF 69 Framework C ONTENTS paragraphs PREFACE INTRODUCTION 1–11 Purpose and status 1–4 Scope 5–8 Users and their information needs 9–11 THE OBJECTIVE OF FINANCIAL STATEMENTS 12–21 Financial position, performance and changes in financial position 15–21 Notes and supplementary schedules 21 UNDERLYING ASSUMPTIONS 22–23 Accrual basis 22 Going concern 23 QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS 24–46 Understandability 25 Relevance 26–30 Materiality 29–30 Reliability 31–38 Faithful representation 33–34 Substance over form 35 Neutrality 36 Prudence 37 Completeness 38 Comparability 39–42 Constraints on relevant and reliable information 43–45 Timeliness 43 Balance between benefit and cost 44 Balance between qualitative characteristics 45 True and fair view/fair presentation 46 THE ELEMENTS OF FINANCIAL STATEMENTS 47–81 Financial position 49–52 Assets 53–59 Liabilities 60–64 Equity 65–68 Performance 69–73 Income 74–77 Expenses 78–80 Capital maintenance adjustments 81 © 70 IASCF Framework RECOGNITION OF THE ELEMENTS OF FINANCIAL STATEMENTS 82–98 The probability of future economic benefit 85 Reliability of measurement 86–88 Recognition of assets 89–90 Recognition of liabilities 91 Recognition of income 92–93 Recognition of expenses 94–98 MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS 99–101 CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE 102–110 Concepts of capital 102–103 Concepts of capital maintenance and the determination of profit 104–110 © IASCF 71 Framework The Framework has not been amended to reflect the changes made by IAS 1 Presentation of Financial Statements (as revised in 2007). Preface Financial statements are pr epared and presented for exte rnal users by many entities around the world. Although such financial statements may appear similar from country to country, there are differences which have probably been caused by a variety of social, economic and legal circumstances and by different countries having in mind the needs of different users of financial statements when setting national requirements. These different circumstances have led to the use of a variety of definitions of the elements of financial statements; that is, for example, assets, lia bilities, equity, income and expenses. They have also resulted in the us e of different criteria for the recognition of items in the financial statements and in a preference for different bases of measurement. The scope of the financial statements and the disclosures made in them have also been affected. The International Accounting Standards Committee (IASC) is committed to narrowing these differences by seeking to harmonise regulations, accounting standards and procedures relating to the preparation an d presentation of financial statements. It believes that further harmonisation can best be pursued by focusing on financial statements that are prepared for the purpose of providing information that is useful in making economic decisions. The Board of IASC believes that financial statements prepared for this purpose meet the commonneedsofmostusers. Thisisbecausenearlyallusersaremakingeconomic decisions, for example, to: (a) decide when to buy, hold or sell an equity investment; (b) assess the stewardship or accountability of management; (c) assess the ability of the entity to pay and provide other benefits to its employees; (d) assess the security for amounts lent to the entity; (e) determine taxation policies; (f) determine distributable profits and dividends; (g) prepare and use national income statistics; or (h) regulate the activities of entities. The Board recognises, however, that governments, in particular, may specify different or additional requirements for their own purposes. These requirements should not, however, affect financial statements published for the benefit of other users unless they also meet the needs of those other users. Financial statements are most commonly prep ared in accordance with an accounting model based on recoverable historical cost and the nominal financial capital maintenance concept. Other models and concepts may be more appropriate in order to meet the objective of providing information that is useful for making economic decisions although 72 ©IASCF Framework there is presently no consensus for change. This Framework has been developed so that it is applicable to a range of accounting mode ls and concepts of capital and capital maintenance. Introduction Purpose and status s i h 1 T Framework sets out the concepts that underlie the preparation and presentation of financial statements for external users. The purpose of the Framework is to: (a) assist the Board of IASC in the development of future International Accounting Standards and in its review of existing International Accounting Standards; (b) assist the Board of IASC in prom oting harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments pe rmitted by International Accounting Standards; (c) assist national standard-setting bodies in developing national standards; (d) assist preparers of financial stat ements in applying International Accounting Standards and in dealing with topics that have yet to form the subject of an International Accounting Standard; (e) assist auditors in forming an opinion as to whether financial statements conform with International Accounting Standards; (f) assist users of financial statements in interpreting the information contained in financial statements prepared in conformity with International Accounting Standards; and (g) provide those who are interested in the work of IASC with information about its approach to the formulation of International Accounting Standards. s i h 2 T Framework is not an International Accounti ng Standard and hence does not define standards for any particular measurement or disclosure issue. Nothing in this Framework overrides any specific International Accounting Standard. 3 The Board of IASC recognises that in a limited number of cases there may be a conflict between the Framework and an Intern ational Accounting Standard. In those cases where there is a conflict, the requirements of the International Accounting Standard prevail over those of the Framework. As, however, the Board of IASC will be guided by the Framework in the development of future Standards and in its review of existing Standards, the number of cases of conflict between the Framework and International Accounting St andards will diminish through time. e h 4 T Framework will be revised from time to ti me on the basis of the Board’s experience of working with it. © IASCF 73 Framework Scope e h 5 T Framework deals with: (a) the objective of financial statements; (b) the qualitative characteristics that determine the usefulness of information in financial statements; (c) the definition, recognition and meas urement of the elements from which financial statements are constructed; and (d) concepts of capital and capital maintenance. e h 6 T Framework is concerned with general purpose financial statements (hereafter referred to as ‘financial statements’) including consolidated financial statements. Such financial statements are prepared and presented at least annually and are directed toward the common information needs of a wide range of users. Some of these users may require, and have thepower to obtain, information in addition to that contained in the financial statements. Many users, however, have to rely on the financial statements as their ma jor source of financial information and such financial statements should, therefore, be prepared and presented with their needs in view. Special purpose financial reports, for example, prospectuses and computations prepared for taxation purposes, are outside the scope of this Framework. Nevertheless, theFramework may be applied in the preparation of such special purpose reports where their requirements permit. 7 Financial statements form part of the process of financial reporting. A complete set of financial statements normally includes a balance sheet, an income statement, a statement of changes in financial position (which may be presented in a variety of ways, for example, as a statement of cash flows or a statement of funds flow), and those notes and other statements and explanatory material that are an integral part of the financial statements. They may also include supplementary schedules and informat ion based on or derived from, and expected to be read with, such statem ents. Such schedules and supplementary information may deal, for example, with financial information about industrial and geographical segments and disclosures about the effects of changing prices. Financial statements do not, however, include such items as reports by directors, statements by the chairman, discussion and analysis by management and similar items that may be included in a financial or annual report. e h 8 T Framework applies to the financial statemen ts of all commercial, industrial and business reporting entities, whether in the public or the private sectors. A reporting entity is an entity for which there are users who rely on the financial statements as their major source of financial information about the entity. Users and their information needs 9 The users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. They use financial statements in order to 74 © IASCF Framework satisfy some of their different needs for information. These needs include the following: (a) Investors. The providers of risk capital and their advisers are concerned with the risk inherent in, and return provided by, their investments. They need information to help them determine whether they should buy, hold or sell. Shareholders are also interested in information which enables them to assess the ability of the entity to pay dividends. (b) Employees. Employees and their representative groups are interested in information about the stability and profitability of their employers. They are also interested in information which enables them to assess the ability of the entity to provide remuneration, retirement benefits and employment opportunities. (c) Lenders. Lenders are interested in in formation that enables them to determine whether their loans, and the interest attaching to them, will be paid when due. (d) Suppliers and other trade creditors. Suppliers and other creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due. Trade creditors are likely to be interested in an entity over a shorte r period than lenders unless they are dependent upon the continuation of the entity as a major customer. (e) Customers. Customers have an interest in information about the continuance of an entity, especially when they have a long-term involvement with, or are dependent on, the entity. (f) Governments and their agencies . Governments and their agencies are interested in the allocation of resour ces and, therefore, the activities of entities. They also require information in order to regulate the activities of entities, determine taxation policies and as the basis for national income and similar statistics. (g) Public. Entities affect members of the public in a variety of ways. For example, entities may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers. Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the entity and the range of its activities. 10 While all of the information needs of these users cannot be met by financial statements , there are needs which are co mmon to all users. As investors are providers of risk capital to the entity, the provision of financial statements that meet their needs will also meet most of the needs of other users that financial statements can satisfy. 11 The management of an entity has the primary responsibility for the preparation and presentation of the financial statements of the entity. Management is also interested in the information contained in the financial statements even though it has access to additional management and financial information that helps it carry out its planning, decision-making and control responsibilities. Management has the ability to determine the form and content of such additional © IASCF 75 Framework information in order to meet its own need s. The reporting of such information, however, is beyond the scope of thisFramework. Nevertheless, published financial statements are based on the information used by management about the financial position, performance and changes in financial position of the entity. The objective of financial statements 12 The objective of financial statements is to provide information about the financial position, performa nce and changes in financia l position of an entity that is useful to a wide range of users in making economic decisions. 13 Financial statements prepared for this purpose meet the common needs of most users. However, financial statements do not provide all the information that users may need to make economic deci sions since they largely portray the financial effects of past events and do not necessarily provide non-financial information. 14 Financial statements also show the results of the stewardship of management, or the accountability of management for the resources entrusted to it. Those users whowishto assessthestewardshiporaccountabilityofmanagementdosoin order that they may make ec onomic decisions; these decisions may include, for example, whether to hold or sell their investment in the en tity or whether to reappoint or replace the management. Financial position, performance and changes in financial position 15 The economic decisions that are taken byusers of financial statements require an evaluation of the ability of an entity to generate cash and cash equivalents and of the timing and certainty of their generation. This ability ultimately determines, for example, the capacity of an entity to pay its employees and suppliers, meet interest payments, repay loans and make di stributions to its owners. Users are better able to evaluate this ability to generate cash and cash equivalents if they are provided with information that focuses onthe financial position, performance and changes in financial position of an entity. 16 The financial position of an entity is affected by the economic resources it controls, its financial structure, its li quidity and solvency, and its capacity to adapt to changes in the environment in which it operates. Information about the economic resources controlled by the entity and its capacity in the past to modify these resources is useful in predicting th e ability of the entity to generate cash and cash equivalents in the future. Information about financial structure is useful in predicting futu re borrowing needs and how future profits and cash flows will be distributed am ong those with an interest in the entity; it is also useful in predicting how successful the en tity is likely to be in raising further finance. Information about liquidity and solvency is useful in predicting the ability of the entity to meet its financial commitments as they fall due. Liquidity refers to the availability of cash in the near future after taking account of financial commitments over this period. Solvency refers to the availability of cash over the longer term to meet financial commitments as they fall due. 76 © IASCF Framework 17 Information about the performance of an en tity, in particular its profitability, is required in order to assess potential changes in the economic resources that it is likely to control in the future. Information about variability of performance is important in this respect. Information about performance is useful in predicting the capacity of the en tity to generate cash flows from its existing resource base. It is also useful in forming judgements about the effectiveness with which the entity might employ additional resources. 18 Information concerning changes in the financial position of an entity is useful in order to assess its investing, financing and operating activities during the reporting period. This information is useful in providing the user with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilise those cash flows. In constructing a statement of changes in financial position, funds can be defined in various ways, such as all financial resources,workingcapital,liquidassetsorcash. Noattemptismadeinthis Framework to specify a definition of funds. 19 Information about financial position is primarily provided in a balance sheet. Information about performanc e is primarily provided in an income statement. Information about changes in financial po sition is pr ovided in the financial statements by means of a separate statement. 20 The component parts of the financial statements interrelate because they reflect different aspects of the same transact ions or other even ts. Although each statement provides information that is different from the others, none is likely to serve only a single purposeor provide all the information necessary for particular needs of users. For example, an income statement provides an incomplete picture of performance unless it is used in conjunction with the balance sheet and the statement of changes in financial position. Notes and supplementary schedules 21 The financial statements also contai n notes and supplementary schedules and other information. For example, they may contain additional information that is relevant to the needs of users about the items in the balance sheet and income statement. They may include disclosures about the risks and uncertainties affecting the entity and an y resources and obligations not recognised in the balance sheet (such as mineral reserves). Information abou t geographical and industry segments and the effect on the entity of changing prices may also be provided in the form of supplementary information. Underlying assumptions Accrual basis 22 In order to meet their objectives, financial statements are prepared on the accrual basis of accounting. Under this basis, the effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded inthe accounting records and reported in the financial statements of the periods towhich they relate. Financial statements prepared on the accrual basisinform users not only ofpast transactions involving © IASCF 77 Framework the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the future. Hence, they provide the type of information about past transactions and other events that is most useful to users in making economic decisions. Going concern 23 The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entityhas neither the intent ion nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed. Qualitative characteristics of financial statements 24 Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The four principal qualitative characteristics are understandability, relevance, reliability and comparability. Understandability 25 An essential quality of the information provided in financial statements is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information wi th reasonable diligence. However, information about complex matters that should be included in the financial statements because of its relevance to the economic decision-making needs of users should not be excluded merely on the grounds that it may be too difficult for certain users to understand. Relevance 26 To be useful, information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them eval uate past, present or future events or confirming, or correcting, their past evaluations. 27 The predictive and confirmatory roles of information are interrelated. For example, information about the current level and structure of asset holdings has value to users when they endeavour topredict the ability of the entity to take advantage of opportunities and its ability to react to adverse situations. The same information plays a confirmatory role in respect of past predictions about, for example, the way in which the entity would be structured or the outcome of planned operations. 28 Information about financial position and past performance is frequently used as the basis for predicting future financ ial position and performance and other matters in which users are directly interested, such as dividend and wage payments, security price movements and the ability of the entity to meet its commitments as they fall due. To have predictive value, information need not be 78 © IASCF Framework in the form of an explicit forecast. The ability to make predictions from financial statements is enhanced, however, by th e manner in which information on past transactions and events is displayed. For example, the predictive value of the income statement is enhanced if unusual, abnormal and infrequent items of income or expense are separately disclosed. Materiality 29 The relevance of information is affected by its nature and ma teriality. In some cases, the nature of information alone is sufficient to dete rmine its relevance. For example, the reporting of a new segm ent may affect the assessment of the risks and opportunities facing the entity irresp ective of the materiality of the results achieved by the new segment in the reporting period. In other cases, both the nature and materiality are impo rtant, for example, the amounts of inventories held in each of the main categories that are appropriate to the business. 30 Information is material if its omissi on or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omissi on or misstatement. Thus , materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful. Reliability 31 To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. 32 Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading. For example, if the validity and amount of a claim for damages under a legal action are disputed, it may be inappropriate for the entity to recognise the full amount of the claim in the balance sheet, although it may be ap propriate to disclose the amount and circumstances of the claim. Faithful representation 33 To be reliable, information must represent faithfully the transactions and other events it either purports to represen t or could reasonably be expected to represent. Thus, for example, a balanc e sheet should represent faithfully the transactions and other events that result in assets, liabilities and equity of the entity at the reporting date which meet the recognition criteria. 34 Most financial information is subject to some risk of being less than a faithful representation of that which it purports to portray. This is not due to bias, but rather to inherent difficulties either in identifying the transactions and other events to be measured or in devi sing and applying measurement and presentation techniques that can convey messages that correspond with those transactions and events. In certain cases, the measurement of the financial © IASCF 79 Framework effects of items could be so uncertain that entities generally would not recognise them in the financial statements; for example, although most entities generate goodwill internally over time, it is usua lly difficult to identify or measure that goodwill reliably. In other cases, however, it may be relevant to recognise items and to disclose the risk of error surrounding their recognition and measurement. Substance over form 35 If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form. For example, an entity may dispose of an asset to another party in such a way that the documentation purports to pass legal ownership to that party; nevertheless, agreements may exist that ensure that the entity continues to enjoy the future economic benefits embodied in the asset. In such circumst ances, the reporting of a sale would not represent faithfully the transaction entered into (if indeed there was a transaction). Neutrality 36 To be reliable, the information contained in financial statements must be neutral, that is, free from bias. Financial statements are not neutral if, by the selection or presentation of information, they influence the making of a decision or judgement in order to achieve a predetermined result or outcome. Prudence 37 The preparers of financial statements do, however, have to contend with the uncertainties that inevitably surround many events and circumstances, such as the collectability of doubtful receivables, the probable useful life of plant and equipment and the number of warran ty claims that may occur. Such uncertainties are recognised by the disclosure of their nature and extent and by the exercise of prudence in the preparation of the financial statements. Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabil ities or expenses are not understated. However, the exercise of prudence does not allow, for example, the creation of hidden reserves or excessive provisions, the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial statements would not be neutral and, therefore, not have the quality of reliability. Completeness 38 To be reliable, the information in financial statements must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance. 80 © IASCF Framework Comparability 39 Users must be able to compare the financial statements of an entity through time in order to identify trends in its financial position and performance. Users must also be able to compare the financial stat ements of different entities in order to evaluate their relative financial position, performance and changes in financial position. Hence, the measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and over time for that enti ty and in a consistent way for different entities. 40 An important implication of the qualitative characteristic of comparability is that users be informed of the accounting policies employed in the preparation of the financial statements, any changes in those policies and the effects of such changes. Usersneed to be able to id entify differences between the accounting policies for like transactions and other events used by the same entity from period to period and by different entities. Compliance with International Accounting Standards, including the disclosure of the accounting policies used by the entity, helps to achieve comparability. 41 The need for comparability should not be confused with mere uniformity and should not be allowed to become an impediment to the introduction of improved accounting standards. It is not appropri ate for an entity to continue accounting in the same manner for a transaction or other event if the policy adopted is not in keeping with the qualitative characteristics of relevance and reliability . It is also inappropriate for an entity to leave itsaccounting policies unchanged when more relevant and reliable alternatives exist. 42 Because users wish to compare the financial position, performance and changes in financial position of an entity over time, it is important that the financial statements show corresponding information for the preceding periods. Constraints on relevant and reliable information Timeliness 43 If there is undue delay in the reporting of information it may lose its relevance. Management may need to balance the relative merits of timely reporting and the provision of reliable information. To provide information on a timely basis it may often be necessary to report before all as pects of a transaction or other event are known, thus impairing reliability. Conver sely, if reporting is delayed until all aspects are known, the information may be highly reliable but of little use to users whohavehad tomake decisionsin theinterim. In achieving abalance between relevance and reliability, the overriding consideration is how best to satisfy the economic decision-making needs of users. Balance between benefit and cost 44 The balance between benefit and cost is a pervasive constraint rather than a qualitative characteristic. The benefits derived from information should exceed the cost of providing it. The evaluati on of benefits and costs is, however, substantially a judgemental process. Fu rthermore, the costs do not necessarily © IASCF 81 Framework fall on those users who enjoy the benefits. Benefits may also be enjoyed by users other than those for whom the inform ation is prepared; for example, the provision of further information to lenders may reduce the borrowing costs of an entity. For these reasons, it is difficult to apply a cost-benefit test in any particular case. Nevertheless, standard-setters in particular, as well as the preparers and users of financial statements, should be aware of this constraint. Balance between qualitative characteristics 45 In practice a balancing, or trade-off, between qualitative characteristics is often necessary. Generally the aim is to ac hieve an appropriate balance among the characteristics in order to meet the objective of financial statements . The relative importance of the ch aracteristics in different case s is a matter of professional judgement. True and fair view/fair presentation 46 Financial statements are frequently described as showing a true and fair view of, or as presenting fairly, the financia l position, performa nce and changes in financial position of an entity. Although this Framework does not deal directly with such concepts, the application of the principal qualitative characteristics and of appropriate accounting standardsnormally results in financial statements that convey what is gene rally understood as a true and fair view of, or as presenting fairly such information. The elements of financial statements 47 Financial statements portray the fina ncial effects of transactions and other events by grouping them into broad classes acco rding to their economic characteristics. These broad classes are termed the elements of financial statements. The elements directly related to the measurement of financial position in the balance sheet are assets, liabilities and equity. The elements directly related to the measurement of performance in the income statement are income and expenses. The statement of changes in financial position usually reflects income statement elements and changes in balance sheet elements; accordingly, this Framework identifies no elements that are unique to this statement. 48 The presentation of these elements in the balance sheet and the income statement involves a process of sub-clas sification. For example, assets and liabilities may be classified by their nature or function in the business of the entity in order to display information in the manner most useful to users for purposes of making economic decisions. Financial position 49 The elements directly related to the measurement of financial position are assets, liabilities and equity. These are defined as follows: (a) An asset is a resource controlled by th e entity as a result of past events and from which future economic benefits are expected to flow to the entity. 82 © IASCF Framework (b) A liability is a present obligation of the entity arising from past events, the settlement of which is expected to resu lt in an outflow from the entity of resources embodying economic benefits. (c) Equity is the residual interest in the assets of the entity after deducting all its liabilities. 50 The definitions of an asset and a liabilit y identify their essential features but do not attempt to specify the criteria that need to be met before they are recognised in the balance sheet. Thus, the definitions embrace items that are not recognised as assets or liabilities in the balance sheet because they do not satisfy the criteria for recognition discussed in paragraphs 82 to 98. In particular, the expectation that future economic benefits will flow to or from an entity must be sufficiently certain to meet the probability criterio n in paragraph 83 before an asset or liability is recognised. 51 In assessing whether an item meets the definition of an asset, liability or equity, attention needs to be given to its underlying substance and economic reality and not merely its legal form. Thus, for example, in the case of finance leases, the substance and economic reality are that the lessee acquires the economic benefits of the use of the leased asset for the major part of its useful life in return for entering into an obligation to pay for that right an amount approximating to the fair value of the asset and the related finance charge. Hence, the finance lease gives rise to items that satisfy the defi nition of an asset and a liability and are recognised as such in the lessee’s balance sheet. 52 Balance sheets drawn up in accordance with current International Accounting Standards may include items that do not satisfy the definitions of an asset or liability and are not shown as part of equity. The definitions set out in paragraph 49 will, however, underlie future reviews of existing International Accounting Standards and the formulation of further Standards. Assets 53 The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. The potential may be a produc tive one that is part of the operating activities of the entity. It may also takethe form of convertibility into cash or cash equivalents or a capability to reduce cash outf lows, such as when an alternative manufacturing process lowers the costs of production. 54 An entity usually employs its assets to produce goods or services capable of satisfying the wants or needs of customer s; because these good s or services can satisfy these wants or needs, customers are prepared to pay for them and hence contribute to the cash flow of the entity. Cash itself renders a service to the entity because of its command over other resources. 55 The future economic benefits embodied in an asset may flow to the entity in a number of ways. For example, an asset may be: (a) used singly or in combination with other assets in the production of goods or services to be sold by the entity; (b) exchanged for other assets; ©IASCF 83 Framework (c) used to settle a liability; or (d) distributed to the owners of the entity. 56 Many assets, for example, property, plant and equipment, have a physical form. However, physical form is not essential tothe existence of an asset; hence patents and copyrights, for example, are assets if future economic benefits are expected to flow from them to the entity and if they are controlled by the entity. 57 Many assets, for example, receivables and property, are associated with legal rights, including the right of ownership. In determining the existence of an asset, the right of ownership is not essential; thus, for example, property held on a lease is an asset if the entity controls the benefits which are expected to flow from the property. Although the capa city of an entity to cont rol benefits is usually the result of legal rights, an item may nonetheless satisfy the definition of an asset even when there is no legal control. For example, know-how obtained from a development activity may meet the definition of an asset when, by keeping that know-how secret, an entity controls the benefits that are expected to flow from it. 58 The assets of an entity result from past transactions or other past events. Entities normally obtain assets by purchasing or producing them, but other transactions or events may generate assets; examples include property received by an entity from government as part of a programme to encourage economic growth in an area and the discovery of mineral deposits . Transactions or events expected to occur in the future do not in themselves give rise to assets; hence, for example, an intention to purchase inventory does not, of itself, meet the definition of an asset. 59 There is a close association between incurring expenditure and generating assets but the two do not necessarily coinci de. Hence, when an entity incurs expenditure, this may prov ide evidence that future economic benefits were sought but is not conclusive proof that an item satisfying the definition of an asset has been obtained. Similarly the absence of a related expenditure does not preclude an item from satisfying the defi nition of an asset and thus becoming a candidate for recognition in the balancesheet; for example, items that have been donated to the entity may satisfy the definition of an asset. Liabilities 60 An essential characteristic of a liabilityis that the entity has a present obligation. An obligation is a duty or responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement. This is normal ly the case, for example, with amounts payable for goods and services received. Obligations also arise, however, from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner. If, for example, an entity decides as a matter of policy to rectify faults in itsproducts even when these become apparent after the warranty period has expired, the amounts that are expected to be expended in respect of goods already sold are liabilities. 61 A distinction needs to be drawn between a present obligation and a future commitment. A decision by the management of an entity to acquire assets in the future does not, of itself, give rise taopresent obligation. An obligation normally arises only when the asset is delivered or the entity enters into an irrevocable 84 © IASCF Framework agreement to acquire the asset. In the la tter case, the irrevo cable nature of the agreement means that the economic consequences of failing to honour the obligation, for example, because of the existence of a substantial penalty, leave the entity with little, if any, discretion to avoid the outflow of resources to another party. 62 The settlement of a presen t obligation usually involv es the entity giving up resources embodying economic benefits in order to satisfy the claim of the other party. Settlementofapresentobligati on may occur in a number of ways, for example, by: (a) payment of cash; (b) transfer of other assets; (c) provision of services; (d) replacement of that obligation with another obligation; or (e) conversion of the obligation to equity. An obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its rights. 63 Liabilities result from past transactions or other past events. Thus, for example, the acquisition of goods and the use of services give rise to trade payables (unless paid for in advance or on delivery) and the receipt of a bank loan results in an obligation to repay the loan. An entitymay also recognise future rebates based on annual purchases by customers as liabilities; in this case, the sale of the goods in the past is the transaction that gives rise to the liability. 64 Some liabilities can be measured only by using a substantial degree of estimation. Some entities describe these liabilities as provisions. In some countries, such provisions are not regarded as liabiliti es because the concept of a liability is defined narrowly so as to include only amounts that can be established without the need to make estimates. The definition of a liability in paragraph 49 follows a broader approach. Thus, when a prov ision involves a present obligation and satisfies the rest of the definition, it is a liability even if the amount has to be estimated. Examples include provisions for payments to be made under existing warranties and provisions to cover pension obligations. Equity 65 Although equity is defined in paragraph 49 as a residual, it may be sub-classified in the balance sheet. For example, in a corporate entity, funds contributed by shareholders, retained earnings, reserves representing appropriations of retained earnings and reserves representing ca pital maintenance adjustments may be shown separately. Such classifications can be relevant to the decision-making needs of the users of financial statements when they indicate legal or other restrictions on the ability of the entity to distribute or otherwise apply its equity. They may also reflect the fact that part ies with ownership interests in an entity have differing rights in relation to th e receipt of dividends or the repayment of contributed equity. © IASCF 85 Framework 66 The creation of reserves is sometimes required by statute or other law in order to give the entity and its creditors an added measure of protection from the effects of losses. Other reserves may be established if national tax law grants exemptions from, or reductions in, taxation liabilities when transfers to such reserves are made. The existence and size of these legal, statutory and tax reserves is information that can be relevant to the decision-making needs of users. Transfers to such reserves are appropriations of retained earnings rather than expenses. 67 The amount at which equity is shown in the balance sheet is dependent on the measurement of assets and liabilities. Normally, the aggregate amount of equity only by coincidence corresponds with the aggregate market value of the shares of the entity or the sum that could be raised by disposing of either the net assets on a piecemeal basis or the entity as a whole on a going concern basis. 68 Commercial, industrial and business activities are often undertaken by means of entities such as sole proprietorships, partnerships and trusts and various types of government business undertakings. The legal and regulatory framework for such entities is often different from that appl ying to corporate entities. For example, there may be few, if any, restrictions on the distribution to owners or other beneficiaries of amounts included in eq uity. Nevertheless, the definition of equity and the other aspects of this Framework that deal with equity are appropriate for such entities. Performance 69 Profit is frequently used as a measure of performance or as the basis for other measures, such as return on investment or earnings per share. The elements directly related to the measurement of profit are income and expenses. The recognition and measurement of income and expenses, and hence profit, depends in part on the concepts of capital and capital maintenance used by the entity in preparing its financial statements. These concepts are discussed in paragraphs 102 to 110. 70 The elements of income and expenses are defined as follows: (a) Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decr eases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. (b) Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. 71 The definitions of income and expenses identify their essential features but do not attempt to specify the criteria that would need to be met before they are recognised in the income statement. Cr iteria for the recognition of income and expenses are discussed in paragraphs 82 to 98. 72 Income and expenses may be presented in the income statement in different ways so as to provide information that is relevant for econom ic decision-making. For example, it is common practice to distinguish between those items of income and expenses that arise in the course of the ordina ry activities of the entity and 86 ©IASCF Framework those that do not. This distinction is made on the basis thatthe source of an item is relevant in evaluating the ability ofthe entity to gene rate cash and cash equivalents in the future; for example, in cidental activities such as the disposal of a long-term investment are unlikely to recur on a regular basis. When distinguishing between items in this way consideration needs to be given to the nature of the entity and its operations . Items that aris e from the ordinary activities of one entity may be unusual in respect of another. 73 Distinguishing between items of income and expense and combining them in different ways also permits several me asures of entity performance to be displayed. These have differing degrees of inclusiveness. For example, the income statement could display gross margin, prof it or loss from ordinary activities before taxation, profit or loss from ordinary activiti es after taxation, and profit or loss. Income 74 The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent. 75 Gains represent other items that meet the definition of income and may, or may not, arise in the course of the ordinary activities of an entity. Gains represent increases in economic benefits and as such are no different in nature from revenue. Hence, they are not regarded as constituting a separate element in this Framework. 76 Gains include, for example, those arisin g on the disposal of non-current assets. The definition of income also includes unrealised gains; for example, those arising on the revaluation of marketab le securities and those resulting from increases in the carrying amount of long-term assets. When gains are recognised in the income statement, they are usually displayed separately because knowledge of them is useful for the purpose of making economic decisions. Gains are often reported net of related expenses. 77 Various kinds of assets may be received or enhanced by income; examples include cash, receivables and goods and services received in exchange for goods and services supplied. Income may also result from the settlement of liabilities. For example, an entity may provide goods and services to a lender in settlement of an obligation to repay an outstanding loan. Expenses 78 The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entitExpenses that arise in the course of the ordinary activities of the en tity include, for example, cost of sales, wages and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant and equipment. © IASCF 87 Framework 79 Losses represent other items that meet the definition of expenses and may, or may not, arise in the course of the ordinary ac tivities of the entity . Losses represent decreases in economic benefits and as such they are no different in nature from other expenses. Hence, they are not regarded as a separate element in this Framework. 80 Losses include, for example, those resulting from disasters such as fire and flood, as well as thos e arising on the disposal of non- current assets. The definition of expenses also includes unrealised losses, for example, those arising from the effects of increases in the rate of exchangefor a foreign currency in respect of the borrowings of an entity in that currency. When losses are recognised in the income statement, they are usually displayed separately because knowledge of them is useful for the purpose of making economic decisions. Losses are often reported net of related income. Capital maintenance adjustments 81 The revaluation or restatement of assets and liabilities gives rise to increases or decreases in equity. While these increases or decreases meet the definition of income and expenses, they are not included in the income statement under certain concepts of capital maintenance. Instead these items are included in equity as capital maintenance adjustments or revaluation reserves. These concepts of capital maintenance are discussed in paragraphs 102 to 110 of this Framework. Recognition of the elements of financial statements 82 Recognition is the process of incorporating in the balance sheet or income statement an item that me ets the definition of an element and satisfies the criteria for recognition set out in paragrap h 83. It involves the depiction of the item in words and by a monetary amountand the inclusion ofthat amount in the balance sheet or income statement totals . Items that sati sfy the recognition criteria should be recognised in th e balance sheet or income statement. The failure to recognise such items is not rectified by disclosure of the accounting policies used nor by notes or explanatory material. 83 An item that meets the definition of an element should be recognised if: (a) it is probable that an y future economic benefit associated with the item will flow to or from the entity; and (b) the item has a cost or value that can be measured with reliability. 84 In assessing whether an item meets th ese criteria and ther efore qualifies for recognition in the financial statements, gard needs to be given to the materiality considerations discussed in paragraphs 29and 30. The interrelationship between the elements means that an item that meets the definition and recognition criteria for a particular element, for example, an asset, automatically requires the recognition of another element, for example, income or a liability. 88 © IASCF Framework The probability of future economic benefit 85 The concept of probability is used in therecognition criteria to refer to the degree of uncertainty that the future economic benefits associated with the item will flow to or from the entity. The concep t is in keeping with the uncertainty that characterises the environment in which an entity operates. Assessments of the degree of uncertainty attaching to the flowof future economic benefits are made on the basis of the evidence available whenthe financial statements ar
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